Risk Insider: Martin Eveleigh

Mt. Gox Investors Lost Millions in Bitcoin. Captive Insurance May Mitigate Future Losses

By: | September 28, 2018 • 2 min read
Martin Eveleigh is Chairman of Atlas Insurance Management, which he formed in 2002. He specializes in designing alternative risk transfer programs – particularly risk pools – and captive structures. He can be reached at [email protected]

Cryptocurrency has been an important topic for captive insurance companies as of late. Public attention to cryptocurrencies, such as Bitcoin, tends to focus on the extraordinary rise in their value and the potential investment opportunities, in addition to (lack of) investment risks. However, cryptocurrencies cannot be dissociated from the blockchain technology that creates them, making both the currencies and the blockchain itself subject to risks that go well beyond investment risk.

When broken down, a blockchain is a distributed ledger of transactions made on a network which adheres to a protocol for communication between participating nodes and the validation of new blocks without the control of a central authority. So far, all such transactions are considered immutable, irreversible and therefore invulnerable to fraud.

Knowing these facts, one should ask: If the blockchain is so secure, what risks are there in issuing, owning and storing digital currencies? And how will we deal with those risks?

As ever with emerging risks, there are knowns and unknowns with cryptocurrencies. At this stage in the development of the blockchain universe, the unknowns greatly outnumber the knowns.

As ever with emerging risks, there are knowns and unknowns with cryptocurrencies. At this stage in the development of the blockchain universe, the unknowns greatly outnumber the knowns.

One unknown is the question of legal liability. Conventional value-transfer transactions take place through an intermediary, such as a bank or broker, in other words through an identifiable and accountable legal entity.

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Blockchain transactions take place without an intermediary on a network potentially comprising hundreds if not thousands of nodes spread around the globe. Where is the identifiable legal entity? What was once the legal liability or third-party risk of the intermediary now looks very much like the first-party risk of the transacting party, and one which should perhaps be insured as such.

While the Bitcoin blockchain is considered to be unhacked up to now, the same cannot be said of the cryptocurrency exchanges. Bitfinex and Coinbase have been targeted, with a loss in the case of the Bitfinex breach of $72 million in Bitcoins.

A bigger loss was the disappearance of 850,000 bitcoins from the Mt. Gox exchange that filed for bankruptcy in Japan in 2014. At the time, those coins were worth $500 million. Storage of cryptocurrency also presents a security risk. Coins can be stored in two types of wallets: hot (connected to the internet) or cold (not connected). The first may be susceptible to hacking while the second is a physical device and thus shares risk characteristics with money stuffed under the mattress.

The commercial insurance market is sure to be relatively slow to respond to the emerging risks associated with cryptocurrency. That is very likely to mean that the financing of the risks that are insurable will be by captive insurance companies, where many aspects of insurance coverage, terms and conditions will be developed.

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The R&I Editorial Team can be reached at [email protected]